In the process of attempting to front-run the aforementioned phase transition, we are employing our Tactical Asset Class Rotation Model (TACRM) to ardently watch for two signals from the U.S. equity market:

Why do we anchor on our proprietary VAMDMI reading rather than single-factor price momentum? Because we have no clue from what duration the preponderance of investors are measuring momentum on – other than that as volatility accelerates, the average investor shortens his/her investment horizon (something we solve for in TACRM).

In light of that, all we can do is record and amalgamate price momentum from multiple durations, adjusting for volatility in the process. This process gives us the best probability of determining where an investor might feel compelled to chase outperformance or blow out of underperforming exposures.

Isolating our search to the top-10 U.S. equity sectors and style factors we track in TACRM (47 in total), we see that 4 of those 10 are fairly new entrants and can be attributed to #Quad1 expectations (Financials: XLF, IAI, KIE; Tech: SMH), while the other 6 are unequivocal winners in #Quad4 (Healthcare: XLV, IBB, IHE, IHI; REITS: VNQ; Utilities: XLU) and have remained in/around the top-10 for months. Moreover, 9 of the bottom-11 VAMDMI readings are sectors and style factors are distinct losers in #Quad4 (Energy: XLE, AMLP, XOP, IEZ; Materials: XLB, GDX; Small-to-Mid Caps: IWM, IWN, IWO) and have also remained in/around the bottom-10 for months.

All told, it can be said that the market continues to price in #Quad4 at the sector and style factor level.

#Quad4(introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.

#Bubbles(introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.

The securities highlighted above represent our top ten investment recommendations based on our active macro themes, which themselves stem from our proprietary four-quadrant Growth/Inflation/Policy (GIP) framework. The securities are ranked according to our calculus of the immediate-term risk/reward of going long or short at the prior closing price, which itself is based on our proprietary analysis of price, volume and volatility trends.

Effectively, it is a dynamic ranking of the order in which we’d buy or sell the securities today – keeping in mind that we have equal conviction in each security from an intermediate-term absolute return perspective.

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12/09/14 08:14 AM EST

#Deflation Trends Continue

Client Talking Points

DEFLATION

Expectations continue to rise as prices linked to inflation expectations continue to crash (Russia down another -1.9% this morning to -38.5% year-to-date); the domino risk of deflation from Oil to Energy Stocks and Bonds doesn’t stop there – Policies to Inflate have dominated headlines for half a decade.

OIL

Oil crashed clocked in at -42% (from June!) then bounced right off that $62.21 oversold level we gave you yesterday; dynamic and non-linear situation continues with a refreshed risk range of $61.27-68.02/barrel; you’d need to bounce well beyond the top-end of that range to get energy stock/bond bulls back to breakeven.

VOLUME

The trend of accelerating volume on DOWN days continues – yesterday’s Total U.S. Equity Market Volume was +25% and +17% vs. its 1mth and 3mth averages, respectively.

Asset Allocation

CASH

62%

US EQUITIES

0%

INTL EQUITIES

0%

COMMODITIES

0%

FIXED INCOME

31%

INTL CURRENCIES

7%

Top Long Ideas

Company

Ticker

Sector

Duration

EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).

XLP

The U.S. is in Quad #4 on our GIP (Growth/Inflation/Policy) model, which suggests that both economic growth and reported inflation are slowing domestically. As far as the eye can see in a falling interest rate environment, we think you should increase your exposure to slow-growth, yield-chasing trade and remain long of defensive assets like long-term treasuries and Consumer Staples (XLP) – which work decidedly better than Utilities in Quad #4. Consumer Staples is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.

Bayesian Answers

“It solved practical questions that were unanswerable by any other means.”

-Sharon Bertsch Mcgrayne

That’s how Sharon Bertsch Mcgrayne summarizes using a Bayesian approach to problem solving in an important book for your risk management library – The Theory That Would Not Die.

“Although Bayes’ Rule drew the attention of the greatest statisticians of the 20th century, some of them vilified both the method and its adherents, crushed it, and declared it dead… In discovering its value for science, many supporters underwent a near-religious conversion yet had to conceal their use of Bayes’ Rule and pretend they employed something else.”

Sound familiar?

Much like during Bayes’ revolutionary times (18th century), where “mathematics was split along religious and political lines” (pg 4), today we are at the crossroad for the same in economic analysis. If you tell me what someone’s political and/or financial motivation is, I can usually predict their answers. If you’re Bayesian in your approach, your answers are far less certain.

#EmbraceUncertainty

Back to the Global Macro Grind…

We hosted an astute group of RIAs (Registered Investment Advisors) at HedgeyeHQ after the close yesterday where I gave a teach-in on our #process. One of the main examples I like to use is Bayes trying to locate a billiard ball’s location (blindly) on a table…

Each incremental throw gives you more information on where the ball is not. After multiple throws, you can narrow the probability of the ball’s location to a probable range. I call this the Risk Range. And I have no business telling the table where the ball has to be.

What happens if there are multiple competitors at the table, all racing to figure out where the ball is at the same time? That’s what makes a market. Whether you like my competitive style or not, I fully intend on coming out of the room with the ball (read Diary of a Hedge Fund Manager for details!).

If you want to beat your competitors in this game, not only do you need to play your game (read: #process), but you need to understand where the other players at the table are positioned and why. One really simple way to look at this from a consensus hedge fund positioning perspective is through CFTC Non-Commercial net LONG/SHORT futures/options.

I cite the rate of change in this Bayesian information as frequently as I can, but whether I do in a timely fashion or not doesn’t mean that the information ceases to exist. Yesterday’s rip (higher) in the Long Bond (TLT +1.2%) and drop in the SP500 (SPY -0.73%) can be (partly, but importantly) explained by the Consensus Macro’s net positioning as of Friday’s close:

Long Bond (10yr Treasury) net SHORT position got way shorter (-91,399 contracts) to a net short position of -173,755

In other words, into the “everything is awesome” jobs cheerleading report:

Consensus Macro ramped to the highest NET LONG position (in SP500 futures/options) terms of 2014, and…

They took the NET SHORT position in the Long Bond to a fresh YTD high

#Nice

“So”, no matter what you think consensus is… that’s what it was - and the next Bayesian probabilities to weigh have everything to do with why consensus is positioned that way. Isolating why on both GROWTH and INFLATION, here are a few A/B tests (toss the ball):

A) On GROWTH, they must think US growth, employment, wages etc. are fixing to achieve some sort of “escape velocity”…

B) Or they realize that even if they are wrong on growth… that the Fed, BOJ, and ECB bails them out anyway

While its perverse, that B) scenario is credible. It’s the levered-long heads you win, tails you win bet – throw the ball anywhere on the table (other than the Russell 2000 and Energy stocks) and you win, right? How about we roll the queue ball on INFLATION?

A) As #deflation expectations accelerate, consensus must think the Fed is going to raise rates into that? …

B) Or that consumption growth is going to be so strong that the Fed will dismiss #deflation as a risk and hike anyway

The problem with what we call the #Quad1 scenario: A) US growth accelerating B) on inflation decelerating is that it’s a theory, not yet a reported reality. And that’s the thing about theories – they are for people who are smarter than me that don’t need to keep taking more reps with the uncertainty ball. They just need a survey confirming their pre-determined belief.

What if McDonalds (MCD) reporting a down -4.6% year-over-year same store sales number for November has something to do with the non-Wall Street economy that still has no wage growth? What if the recent Retail Sales, real personal consumption growth, and jobless claims numbers reported by the government are right (they’ve been slowing)?

Well, that will make Friday’s Consensus Macro position in SPY vs TLT wrong… and it might remind some of us that practical questions are unanswerable by any other means than by embracing the uncertainty of each risk management day.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.16-2.32%

SPX 2051-2075

RUT 1148-1175

VIX 12.83-15.56

WTI Oil 61.27-68.02

Copper 2.84-2.93

Best of luck out there today,

KM

Keith R. McCullough Chief Executive Officer

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12/09/14 07:57 AM EST

December 9, 2014

BULLISH TRENDS

BEARISH TRENDS

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12/09/14 07:54 AM EST

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – December 9, 2014

As we look at today's setup for the S&P 500, the range is 24 points or 0.45% downside to 2051 and 0.71% upside to 2075.

2pm: Sec. of State John Kerry testifies at Senate Foreign Relations Cmte hearing on use of military force against ISIL

WHAT TO WATCH:

Repsol Is Said to Revive Talks With Talisman Energy Over Possible Deal

SEC Said to Seek Standard & Poor’s Suspension of CMBS Rating

Fed ‘Considerable Time’ Rate Pledge Under Scrutiny Ahead of FOMC

Sumitomo Mitsui Said to Buy Citigroup Japan Retail Bank

Cubist Barred From Blocking Generic Cubicin Beyond 2016

JPMorgan Said Among Banks Telling Clients to Take Cash Elsewhere

China Spurs Bond Rout as Riskier Debt Removed From Repo Market

Big Banks Face U.S. Capital Rule Tougher Than Global Agreement

Deutsche Bank Sued by U.S. for Alleged Scheme to Evade Taxes

U.S. Spending Plan to be Unveiled Today as Funding Deadline Nears

CIA Torture Report Set for Senate Release

Valeant to Stop Acquisitions in Near Term: Reuters

Lone Star Said to Compete With Springleaf in Bid for Citigroup’s OneMain

Obama Proposes Expanding China Solar-Cell Levy to New Suppliers

Greek Government Bonds Drop as Presidency Vote Brought Forward

EARNINGS:

Analogic (ALOG) 4:15pm, $0.41

AutoZone (AZO) 7am, $7.16

Conn’s (CONN) 7am, $0.68

HD Supply (HDS) 6am, $0.53

Hudson’s Bay (HBC CN) 7am, C$0.06

John Wiley (JW/A) 8am, $0.84

Krispy Kreme Doughnuts (KKD) 4:05pm, $0.19

NCI Building Systems (NCS) 4:05pm, $0.17

Transcontinental (TCL/A CN) 8:05am, C$0.74

UTi Worldwide (UTIW) 8am, $0.05

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

Crude Rebounds From Five-Year Low Amid Shale-Oil Spending Curbs

Iron Ore Outlook Cut by JPMorgan as BHP, Rio Shares Extend Slump

Kuwait Sees Oil Stuck at $65 for Six Months Until OPEC Moves

Cheap Oil Also Means Cheap Copper, Corn and Sugar: Commodities

El Nino-Like Weather Seen by Morgan Stanley in South America

Gold Rises a Second Day as Lower Dollar and Equities Spur Demand

Iraq Follows Saudis Discounting Oil for Asia to 11-Year Low

Nickel Leads Industrial-Metals Declines on China Demand Concern

OPEC Early Meeting Seen More Likely by Analysts Amid Price Fall

Anglo American Cuts Capex, Sees 2016 Div. Funded From Cashflow

New York’s Snow Lovers to Get Stuck With Rain in Storm Pinwheel

Wheat Drops on Warmer Black Sea Weather, Slow U.S. Export Demand

Bullion Board Seen by Council as Way to Manage India Gold Demand

Putin Plan to Ship Gas to Europe Via Turkey Seen as Unrealistic

More Beef From Down Under Heading for U.S. Tables as Herd Drops

CURRENCIES

GLOBAL PERFORMANCE

EUROPEAN MARKETS

ASIAN MARKETS

MIDDLE EAST

The Hedgeye Macro Team

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